Decomposing household, professional and market forecasts on inflation: a dynamic factor model analysis

Joseph Palardy and Tomi Ovaska ()

Applied Economics, 2015, vol. 47, issue 20, 2092-2101

Abstract: A dynamic factor model with stochastic volatility is used to investigate the relationships between three alternative measures of inflation expectations. The results show evidence of both a common time-varying trend and a common transitory component between inflation and short-term inflation expectations from households, professionals and markets. While the common time-varying trend has declined in both level and volatility since the early 1980s, it was found that consumer expectations are disproportionately influenced by the visibility of prices of select few goods. Roughly speaking, a 1% point increase in food and energy prices leads to about 1/3% point increase in consumer forecasts of inflation. In terms of policymaking, this finding suggests that stability in highly visible prices can moderate inflation in a meaningful way.

Date: 2015
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DOI: 10.1080/00036846.2014.1002889

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